Sunday, April 09, 2006

How to Increase National Saving

Brad DeLong (econ prof at Berkeley, former ec 10 student and assistant prof at Harvard, and super-blogger) welcomes me to the blogosphere at his blog and then complains about my post on the trade deficit. He thinks that I am being "elliptical" for saying I would like to see an increase national saving. I thought that my statement was pretty clear, but I am happy to explain to Brad what I mean.

I suppose Brad wants to know how I would increase national saving. Part of the answer is that tax policy could do more to encourage private saving. I have long been an advocate of moving the tax system in the direction of a consumption tax. The Hall-Rabushka flat tax or the Bradford X tax would be ideal. But one can also do incremental reform within the current tax structure. I would, for example, vastly expand the opportunities for tax-deferred saving, such as IRAs and 401k plans. I would like to move toward allowing corporations to expense all capital investments.

I also think there is some compelling evidence coming out of the behavioral economics literature that the details of savings plans matter a lot for how successful they are. My colleague David Laibson has put together some persuasive evidence that the default is crucial. If workers are automatically enrolled in 401k plans, and have the option of opting out, participation is much higher than if workers have to actively opt-in, as is usually the case today.

The other piece of the national saving picture is public saving. A smaller federal budget deficit would mean more national saving, less reliance on foreign capital flows, and a smaller trade deficit. The trade deficit and the budget deficit are not twins, but they are cousins.

As anyone who has looked at the numbers knows, the federal government’s current budget deficit is, in a sense, only the tip of the iceberg of the fiscal problems to come. The federal budget is on an unsustainable path. When the baby-boom generation retires and becomes eligible for Social Security and Medicare, all hell is going to break loose. The policy options aren’t pretty—either large cuts in promised benefits or taxes vastly higher than anything ever experienced in U.S. history. The stalemate over Social Security reform that we have seen over the last year suggests that the Washington establishment is not ready for the bipartisan consensus that will be necessary to put the budget on a sustainable path.

In my view, there is plenty of blame on both sides of the aisle. The Democrats are not willing to entertain significant cuts in entitlement programs, but they are also not willing to admit that large tax increases that would be necessary to fund those programs as they currently exist. They talk as if reversing the Bush tax cuts on those making over $200,000 would solve the problem, even though the funding gap is far too large for such an easy fix. Similarly, the Republicans will not entertain talk of any tax increases, even as they expand entitlement spending with a costly bill to expand Medicare spending to cover prescription drugs.

If you were to take a poll of the American Economic Association about how to deal with the looming problem of entitlement spending, I believe that many would say that we should gradually phase in a significant increase in the retirement age. That would certainly be a large part of my preferred solution. Yet when pollsters ask the general public about the various ways to reform entitlements, raising the retirement age is one of the least popular possible reforms. This is why you don’t often hear politicians talking about it.

I have frequently wondered why there is such a large gap between economists’ view of raising the retirement age and the public’s view. One possibility is that we enjoy our jobs more than average, so working longer seems less onerous to us than it does to other people. Another possibility, however, is that we have thought about the policy options more thoroughly than others have, and we realize that raising the retirement age may be the best of a bad lot. If that is the case, and I suspect it is, then we need to embark on a course of public education. The entitlement crunch is only a decade or two away. The sooner we act, the better.

Update and clarification: When I say "raise the retirement age," I mean raise the age at which people become eligible for government-financed retirement benefits, such as Social Security and Medicare. I don't object to people retiring early if they do it on their own nickel rather than the taxpayer's. I may even do it myself someday, so I can become a full-time blogger.

About Me

I am the Robert M. Beren Professor of Economics at Harvard University, where I teach introductory economics (ec 10). I use this blog to keep in touch with my current and former students. Teachers and students at other schools, as well as others interested in economic issues, are welcome to use this resource.